FOMC

At this week’s meeting of the Federal Open Market Committee (FOMC), U.S. Fed Chair Jerome Powell said the committee was encouraged with the progress that has been made on returning inflation to the Fed’s long term 2% target.

While they’re not yet in a position to start cutting interest rates, Powell said he felt that cuts would most likely happen ‘sometime’ this year.

Price action in the bond market suggests bond traders have heard the still higher for a little longer, whereas equity bulls have their earplugs in. Nothing changes, right?

For the Fed governors, inflation is moving on a somewhat bumpy road, back down to 2% and in the meantime, they will continue to weigh their dual mandate in light of the following policy scenarios:

• Cut too late in the face of moderating wage growth and risk an unnecessary dampening effect on employment.

• Cut too soon and risk a return of inflation and unstable prices.

What now for the Federal Funds Rate?

The committee wants higher confidence before making a move.

If there is an increase in prices, it will be higher rates for longer, whereas a weakness in employment would be instructive for higher rates for shorter.

During the presser Powell said the recent higher than expected CPI and PCE prints might be explained by seasonal effects, but he’s not sure if that’s just a bump in the road or not.

Meanwhile, here’s what committee members (represented by dots) think rates will look like over the next three years, and in the long-term (i.e., the neutral rate) with notations added by yours truly.

There was a clear uptick in the longer run neutral rate, plus a 25-basis point uptick in the 2025 and 2026 plots.

This is consistent with the Fed’s revised economic forecast.

And while the committee does not predict the number of rate cuts, the median dot plots tabled above suggest up to three 25 basis point rate cuts, per year.

What now for the Fed’s Balance Sheet (reserves/liquidity)

On the balance sheet, the Fed said the run-off will continue at the same $95bn per month pace for the moment, but that it has started to discuss potentially slowing the pace of run off (mainly treasuries) fairly soon, i.e., getting to the same place at a slower pace.

So far, some $1.5 trillion has been run-off and while that means less ‘monetary’ reserve creation, you and I know that liquidity has actually gone up through other means, and you can get a refresher here.

The Fed’s longer term balance sheet goal is to return to a balance sheet that is almost only treasuries. That said, no composition of maturities or terminal level has been discussed.

So, we wait.

Sorry, higher rates for longer.

Mike